LEADING ARTICLE: How the mighty dollar has fallen

Should we care about the dollar's apparently irresistible fall against the Japanese yen? The momentum of the dollar's recent decline may simply show financial markets in one of their periodic Gadarene phases. But the reasons for expecting the dollar to be weak against the yen are sound enough. There are fundamental imbalances in the economic and financial relationship between the largest and second-largest economies in the world. The longer these imbalances continue, the greater the threat to the prosperity of the developed world.

The reasons for the weakness of the dollar are shatteringly simple. For more than a decade the United States has run a deficit on two accounts: the Federal deficit, representing the gap between the government's tax receipts and its payouts; and the current account deficit, representing the gap between foreign earnings and foreign payments. There is a loose link between the two, for both are the product of a similar vice: the desire to consume more than the economy can provide.

It had become fashionable to assume that neither deficit really mattered. People were apparently prepared to buy US government debt to bridge the internal gap, while foreigners were prepared to invest in the US to cover the external gap. That may no longer be a safe assumption.

The reasons behind the strength of the Japanese yen in many ways mirror the weakness of the dollar. Just as the US saves too little, Japan saves too much. The government of Japan has not run a large domestic surplus but Japanese people habitually save more than twice as much as North Americans do as a proportion of their income. And Japan has run large and growing current account surpluses for more than 10 years, surpluses created largely by the social and bureaucratic restrictions the country has placed on importing other countries' goods.

There are other examples of imbalance in the world economy reflected in currency movements. The over-strong German mark may be the result of too tight a monetary policy by the Bundesbank. The collapse of the Italian lira stems from Italy's enormous public sector deficit. But what distinguishes the dollar/yen imbalance is its persistence, and its potential threat to world trade and finance through trade wars and global currency instability.

Left to themselves the markets will correct the imbalance. The dollar will fall to a clearly absurd level and the yen will climb so high that the Japanese government is forced to change policy. But this is a profoundly unsatisfactory and disruptive method of precipitating change. We should be worried. At stake is not just some arcane matter for US and Japanese policy-makers but the preservation of open markets, free trade and an international marketplace which is now being extended to embrace the former centrally planned economies of Russia and China.